19 September 2023

The Lifecycle of a Business - Sole directors – is this still a problem?

Setting up and running your own business is an amazing achievement. It requires vision, creativity, motivation and stamina. On occasion, it can even bring you fame, riches and fortune.

But it can also result in reams of paperwork and cause sleepless nights. And as someone once said to me about children “It doesn’t get easier, it just changes”, so the same can be said for your business throughout its lifecycle. From setting up to exit, it will force you to consider issues that you might not previously have known anything about and it will need you to make many decisions, sometimes very quickly. What it certainly is not is mundane.

With this in mind, the corporate team at Forsters, together with some of our specialist colleagues, has written a series of articles about the various issues and some of the key points that it may help you to know about at each stage of a business’s life. Not all of these will be relevant to you or your business endeavours, but we hope that you will find at least some of these guides interesting and useful, whether you just have the glimmer of an idea, are a start-up, a well-established enterprise or are considering your exit options. Do feel free to drop us a line or pick up the phone if you would like to discuss any of the issues raised further.

Moving on to Directors: Lights, Camera, Action!

Sole directors – is this still a problem? Fore Fitness and Active Wear

Every company has directors to run their affairs and take decisions – but how many do you need? And what are the consequences if your company doesn’t have enough?

There is no need for a company to have a large board of directors. Section 154 of the Companies Act 2006 (the CA 2006) provides that a private company needs just one.

However, the CA 2006 is not the only consideration. The shareholders have a great deal of freedom to adopt rules suitable for their own business in the articles of association. The Model Articles do not include any restrictions on the number of directors, but bespoke articles often do. If the articles set out a minimum number of directors and there is a vacancy, the remaining directors are usually only allowed to act to appoint further directors to bring the board up to its minimum number, or convene a general meeting for the shareholders to do so. If the board tries to act when it doesn’t have enough members, those acts will not be valid, and the directors will be in breach of their duties to the company.

However, the reforms of the CA 2006 were intended to ensure that a company could operate very simply, appointing a sole director and adopting the Model Articles, which under Model Article 7(2) permitted that sole director to exercise all of the company’s powers alone without any regard to the Model Articles regulating decision-making, provided no other provisions of the articles required a minimum number of directors. This is practical, avoids the absurdity of a sole director having to hold a meeting with themselves, and was, until quite recently, considered uncontroversial. Model Article 11(2), which sets the quorum for meetings of the directors at two, was not thought to be inconsistent with Model Article 7(2) – it is patently a provision relating to directors’ decision-making at meetings, so a sole director could safely ignore it as the Model Articles instructed them to do. As a result of these reforms, many companies operate with sole directors under the Model Articles.

Fore Fitness

The decision in Hashmi v Lorimer-Wing (also known as Re Fore Fitness Investments Holdings Ltd) therefore came as an unwelcome shock to many practitioners, as it was decided that the Model Articles were internally inconsistent, and did not permit sole directors to act alone, despite section 154 of the CA 2006.

The judge in Fore Fitness held that the amended Model Article 11(2) in that case, which provided that certain directors were required to form a quorum, was actually to be interpreted as a provision that required the company to have a minimum number of directors, and so Model Article 7(2) did not apply and a sole director could not act. This analysis would apply in the same way to the unamended Model Article 11(2). According to the judge, if a company wanted to operate with a sole director, it was free to amend its articles to permit this.

As a result, the validity of any decision made by a sole director under the Model Articles was called into question!

Re Active Wear

The subsequent decision in Re Active Wear Ltd redressed the balance somewhat. The judge indicated that he did not agree with the reasoning in Fore Fitness, that Model Article 11(2) was plainly a provision relating to directors’ decision-making (falling under that section in the Model Articles and being relevant only to meetings of the board), and held that a sole director could act where the unamended Model Articles applied, or where amended Model Articles were not inconsistent with Model Article 7(2). There should be no need for previous decisions to be ratified. However, the judge was deciding the case before him relating to the appointment of administrators on its particular facts and could not overrule Fore Fitness.

Where are we now?

So, where are we now, and how has this been dealt with in practice? Unfortunately, the Court of Appeal has not yet had the opportunity to clarify the position.

As such, while many companies will take sufficient comfort from Active Wear to avoid incurring the costs and inconvenience of ratifying historic actions, the fact that Fore Fitness has not yet been overruled means that some doubt remains over decisions taken by sole directors operating under the Model Articles. The prudent option is to consider and mitigate the risk by amending the articles to make clear that the sole director can act alone, or to appoint further directors – of course there is a cost and inconvenience in doing so, but companies will find that many of their counterparties, especially on larger transactions involving commercial lenders, are also adopting a cautious approach, and will insist on amendments to the articles or additional directors being appointed.

While it is impossible to predict when (and if) the Court of Appeal will eventually overrule Fore Fitness, it is worth bearing in mind that there will doubtless be thousands of small companies with single directors and Model Articles wholly unaware of these conflicting rulings and conducting business as usual today without any idea that their acts are of questionable validity. If the Court of Appeal does not rule in line with this commercial reality (and, we would humbly suggest, with the plain reading of the Model Articles) there will be enormous scope for decisions to be unpicked or challenged, and day-to-day company decision-making will be made needlessly more onerous until the law can be changed.

Disclaimer

This note reflects the law as at 19 September 2023. The circumstances of each case vary and this note should not be relied upon in place of specific legal advice.

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